Market Close: Munis Slightly Weaker As Deals Remain Rare

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This is no longer a reversal of the flight to quality. Municipal bonds are flat-out weak.

Stung by illiquidity and thin demand, tax-exempt bonds sold off Wednesday by four basis points at all maturities from five to 20 years, according to the Municipal Market Data scale.

At 3.15%, the 10-year triple-A municipal yield has now surged 24 basis points in the last 10 trading days.

The early stages of this updrift in yields could be described as an unwinding of the flight to safety that bolstered municipals earlier in the month. Investors sought the safe haven of Treasuries and other high-quality dollar-denominated bonds in the aftermath of the earthquake in Japan and the civil unrest in North Africa and the Middle East, pulling yields down.

As that play retrenched, yields climbed back up.

People aren’t talking about a flight-to-quality reversal anymore. They’re talking about illiquidity, thin demand, and an inability to digest even an extraordinarily light amount of supply.

“It doesn’t seem like the bid-side’s very strong,” a trader in New Jersey said, citing “loads and loads” of bids wanted.

Bondholders were seeking bids on $800 million of municipal bonds yesterday, according to a Bloomberg LP index.

One trader in Chicago pointed at that MMD in one of its intraday reads pushed yields on its scale up by four basis points for 10-year maturities almost as soon as the market opened. That freaked people out, this trader said, because nobody wants to have to mark down the value of inventory just as the quarter is ending.

The unease showed in the pricing of the day’s biggest deal, the Florida Board of Education’s $175 million sale in the competitive market, with the winning bid coming from Bank of America Merrill Lynch. The 2020 maturity of that deal priced at 3.48%, or about 50 basis points above the triple-A scale.

“All of a sudden they’re backing their bids off,” the trader in Chicago said. “It’s self-determining. ... It was kind of a self-fulfilling prophecy.”

Maybe so, but we would argue that if MMD’s guess at weaker bonds can trigger bonds to weaken in real life — this during an extreme supply drought, mind you — that speaks volumes about how vulnerable the market is.

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